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Income Inequality

Imagine you live next door to a family. They are poor as poor can be: under-eating, wearing rags, no heat, no cool, little water, etc. They just barely survive. One day, the adults of the household decide to start working more, and they begin trading (ie, buying and selling) with the wider community. In a fairly short time, they go from being poor to being moderately wealthy: more food, better clothing, they have a small, old, but operating car now. They have heat and air conditioning. In short, they’re moving on up. They’re not quite at your and your neighbors’ standard of living yet, but they’re getting there.

Now, one of your neighbors says: “That family…oh, they’re bad news. They’re getting wealthier every day. If they keep growing at this pace, they’re going to leave us in the dust. We have to stop them! I demand we all stop buying from them.”

One would, I should think, reasonably object to such measures. What’s it matter that the neighbor is improving his life? Wealth is not a zero-sum game, and a wealthier neighbor is a good thing for the neighborhood. One would conclude the objecting neighbor is just jealous, just trying to protect his position.

And yet, this is exactly the jealous reasoning employed by protectionists scarcityists. Warren Platt, a self-proclaimed protectionist, leaves the following comment at Carpe Diem the other day:

I disagree with the narrative that China is 50 years behind the USA [in terms of living standards]. They are not. They are par with us, and are growing much, much faster. They will soon leave us in the dust unless something changes.

Ignoring the factual issues with Warren’s comment, even if the Chinese were on par with the US, so what? The US is still an insanely wealthy nation. So long as we resist a glade into scarcityism and socialism, that will continue to be. What’s it matter if another nation approaches or surpasses us? That is no reason to impose tariffs to harm both us and them!

China has spent much of the past century in the muck and mire of human poverty, and now that they are finally pulling themselves up, the objection is they threaten our relative position, and must be cast back down.

There are lots of poor arguments for scarcityism, but this is among the worst.

This is a picture of a common programmable coffee maker. For about $60, you can have one of these nearly ubiquitous items. However, 100 years ago, these items were not available. Those rich enough to afford servants were able to have coffee ready for them when they woke up, but many Americans went without this small luxury. However, since this invention came about, ordinary Americans have been able to have what had only previously been available to the very rich: hot coffee ready for them when they awoke in the morning. With other programmable devices like slow-cookers, common Americans can have a whole breakfast waiting for them! The luxuries of the 20th Century uber-rich were commonplace not 100 years later.

This marginal improvement in living standards reminds of of a very important fact: most innovations do not benefit the wealthy, but rather the poor. Indoor plumbing did not benefit the wealthy; it just replaced running servants with running water. It was the great masses of people who benefited from indoor plumbing; those who did not have the running servants.

It’s easy to dismiss capitalism and innovation as only benefiting the rich, since they are seen to be the ones who gain the most monetarily from it. But to do so requires dismissal of the unseen mass of benefits accrued to the poorest, to the common man. These benefits are unseen not because they are hidden, but rather because they are so obvious numerous as to not warrant noticing (similar to how one blinks or breathes without conscience effort for either).

To be fair, these inequalities may be a sign of something amiss. But they alone do not mean something is amiss. With respect to Frued, oftentimes success is just success. A baseball player becomes successful because of hard work and luck, just as a businessman becomes successful through hard work and luck. Their successes (higher home runs/higher profits) are not because of nefarious dealings but the natural end result of their efforts. The fact they outperform their colleagues/competitors is a sign what they are doing is working, and should be encouraged, not deterred. Legislation designed to go after successful people simply because of their successes (re-distributive taxation, windfall profit tax, tariffs, and the like) can and will have the effect of driving down competition, or forcing it away from maximizing gains into more risky and less socially beneficial areas of competition (for example, see Armin Alchain and Reuben Kessel’s 1962 paper Competition, Monopoly, and the Pursuit of Pecuniary Gain.

Discrimination certainly is possible, but is it a likely explanation for these gaps? From an economic point of view, it doesn’t make sense. If we assume that firms are profit-maximizing organizations, then we could reasonably conclude that if wage gaps did exist, and were not some statistical aberration, then firms could easily lay off white men and hire females and minorities to perform the same work for far less, thus increasing profit (indeed, this is suggested as a reasonable course of action in Ms. Bell’s video).

And yet, this does not happen. Why? It certainly is possible that a chauvinistic attitude is rampant throughout the United States and that it is so powerful as to override the profit motive. Were that true, our initial assumption that firms are profit-maximizers would not hold true and would make any policy designed to end this gap difficult to implement since the firms’ operators have a high cost tolerance to the point of sacrificing profit. I suspect that, as the Department of Labor showed some time ago, much of the wage gaps are due to different characteristics and preferences among people.

To the extent that the wage gaps do exist, I suspect they are largely due to policy as opposed to outright discrimination. Policies nominally in favor of women, such as maternity leave or special health benefits increase the cost of female employees relative to men (this is true even if the policy is gender-neutral, but more likely to be used by women). Given the relative cost, men are more attractive to potential employers at a lower price point. Women, to remain competitive, then need to lower their salary expectations.*

There is a similar situation with black-white wages, but this comes about more due to policies like minimum wage. Walter Williams (who is a professor of mine at GMU), has done extensive research on black-white employment and wages since the Bacon-Davis Act (the Act that effectively established a minimum wage). In the decades prior to the Act, unemployment rates and wages were similar among black and white workers. Since the Act, the black unemployment rate has skyrocketed, and with it came falling wages. Since the minimum wage limits teenage unemployment for blacks (a time where valuable skills are learned which do have a dramatic effect on future earnings potential), it trickles down into adult earnings, leading to the gap.

Of course, pure discrimination could be the answer here (although if it were, it’d violate several laws already on the books. Considering no lawsuits have been filed, I doubt it). But, as an economist, I look at things from the point of view of economics: I assume people are, generally speaking, rational, profit-maximizing, self-interested individuals. This assumption is useful enough, and broadly true for the whole population on a number of issues. Furthermore, the idea of price theory (discussed in this post in terms of the cost of discrimination) is broadly true. For either of those assumptions to be overturned, we’d need very compelling evidence. Unfortunately, there mere existence of a wage gap is not compelling enough.

*As an aside, this also makes the cost of discrimination fall. These sorts of policies make it easier for hiring managers to discriminate since there is less of a cost to do so. This is also true for racism.

Mr. Hutcheson’s comment is typical of an oft-made mistake: monetary income is the same as wealth (riches). However, it is by consumption, not money, that we become richer. Let’s look at this in two ways, first with a simple mathematical example, and second with a thought experiment.

Imagine that to live decently (a home, a car, full belly every day, clothing, utilities) costs $1,000 a month. Your salary (income) is $1,000 a month. You break even. Now, let’s say that, though the magic of the market process, the prices of your food, clothing, and utilities falls. It now costs just $800 to maintain the same standard of living. You spend that extra $200 on something nice you couldn’t have before (let’s say a pet). Your wealth has increased by $200 even though your income has stayed the same!

Now, to think about this is a different manner, let’s have a simple thought experiment:

Suppose you see two people. The first man has a home, car, fully belly, etc. The second man is homeless, starving, dressed in tatters, etc. Which of these men would you say is wealthier? You’d probably say the first man. Notice no monetary income was given, but you were able to make a judgement.

None of this is to say that there isn’t a correlation between monetary income and wealth; the absolutely is. But to measure wealth solely upon income is to confuse the issue.

Writing at libertarianism.org, Jason Kuznicki of the Cato Institute writes about American poor. The whole article is interesting, but I want to call attention to one particular quote:

The overwhelming majority of the poor in the United States enjoy technological wonders that didn’t even exist a few decades ago. Outside the free market/liberal democratic synthesis, essentially no other social system has ever delivered as much — because almost none of them can produce a steady stream of new technological innovations in the first place, let alone distribute them to the poor.

I suspect many will discount this quote by simply saying “sure we can buy more iPads, but not important stuff!” but I think it bares remembering that some of the technology referenced includes many household items, like dishwashers, washing machines, refrigerators, cars, clothing, food, education, and so on. “Technology” does not mean just gadgets.

The American poor are not poor by global standards (or even some other 1st World standards). They’ve gotten to this level of “poverty” through the technological achievements Kuznicki discusses.